What is crowdfunding?

Crowdfunding is a way of raising capital in small amounts from a large group of people, using the Internet and social media. For an entrepreneur in need of finance, crowdfunding – also known as crowd source capital – has expanded the pool of investors from whom funds can be raised beyond the traditional lenders.

There are three sets of people involved in the crowdfunding:
  • The people or organisations that propose the ideas and/or projects to be funded.
  • The crowd of people who support the proposals.
  • The organization/website (the "platform") which brings together the project initiator and the crowd.

To kick off the process, the person seeking the funds will set up a profile of their project on a crowdfunding website and can then use social media to pitch their business in order to raise money. There are three different types of crowdfunding: donation, debt and equity.

Donation/Reward crowdfunding

People invest simply because they believe in the cause. Donors have a social or personal motivation for putting their money in and expect nothing back, except perhaps to feel good about helping the project. Non-monetary rewards can be offered to the investor as a token gesture.

Debt crowdfunding

Investors receive their money back with interest. Also called peer-to-peer lending, it allows for the lending of money while bypassing traditional banks. Returns are financial, but investors also have the benefit of having contributed to the success of an idea they believe in. Where very small sums of money are leant to the very poor, most often in developing countries, no interest is paid on the loan and the lender is rewarded by having a social impact.

Equity crowdfunding

People invest in an opportunity in exchange for equity. Money is exchanged for shares, or a small stake in the business, project or venture. As with other types of shares, if it is successful the value goes up. If not, the value goes down.

In the US, crowdfunding is restricted by regulations on who is allowed to fund a new business and how much they are allowed to contribute. These regulations are supposed to protect unsophisticated and/or non-wealthy investors from putting too much of their savings at risk. Because so many new businesses fail, their investors face a high risk of losing their principal.

Various communities in South Africa have been using crowdfunding for many years in the form of stokvels. Each member contributes equal amounts of cash to the pool of fund every month. A member then gets cash allocated to them during the month when it is their turn.

There a vast number of crowdfunding websites globally, aimed at every business industry one can think of. The fact that it’s all done online, means that any small business can source funding from anywhere. Some sites in South Africa are:

  • IndieGoGo: For musicians and film-makers
  • Thundafund: South Africans looking to fund their projects can start here.
  • Crowdinvest: An accredited South African funding platform trying to bring established investors together to fund local projects.

If you can get people to believe in your business or idea, crowdsourcing could be the way to raise capital.

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